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PEOPLES BANCORP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION(Edgar Glimpses Via Acquire Media NewsEdge) SELECTED FINANCIAL DATA The following data should be read in conjunction with the Unaudited Consolidated Financial Statements and the Management's Discussion and Analysis that follows: At or For the Three Months Ended At or For the Nine Months Ended September 30, September 30, 2014 2013 2014 2013 SIGNIFICANT RATIOS Return on average stockholders' equity 5.91 % 4.61 % 6.70 % 7.52 % Return on average assets 0.74 % 0.53 % 0.78 % 0.87 % Net interest margin 3.46 % 3.23 % 3.40 % 3.15 % Efficiency ratio (a) 77.61 % 72.47 % 74.85 % 71.94 % Pre-provision net revenue to average assets (b) 0.97 % 1.26 % 1.14 % 1.25 % Average stockholders' equity to average assets 12.47 % 11.46 % 11.64 % 11.62 % Average loans to average deposits 79.96 % 73.29 % 78.63 % 69.12 % Dividend payout ratio 39.61 % 60.11 % 39.49 % 34.67 % ASSET QUALITY RATIOS Nonperforming loans as a percent of total loans (c)(d) 0.60 % 1.05 % 0.60 % 1.05 % Nonperforming assets as a percent of total assets (c)(d) 0.42 % 0.59 % 0.42 % 0.59 % Nonperforming assets as a percent of total loans and other real estate owned (c)(d) 0.67 % 1.06 % 0.67 % 1.06 % Allowance for loan losses as a percent of loans, net of deferred fees and costs (c)(d) 1.17 % 1.60 % 1.17 % 1.60 % Allowance for loan losses to nonperforming loans (c)(d) 192.71 % 151.79 % 192.71 % 151.79 % (Recovery of) provision for loan losses as a percent of average total loans (0.11 )% (0.35 )% 0.02 % (0.46 )% Net recoveries as a percentage of average total loans (annualized) (0.15 )% (0.26 )% (0.03 )% (0.33 )% CAPITAL RATIOS (d) Tier 1 14.53 % 14.09 % 14.53 % 14.09 % Total (Tier 1 and Tier 2) 15.73 % 15.46 % 15.73 % 15.46 % Tier 1 leverage 10.64 % 9.14 % 10.64 % 9.14 % Tangible equity to tangible assets (e) 9.43 % 8.16 % 9.43 % 8.16 % PER SHARE DATA Earnings per share - Basic $ 0.33 $ 0.24 $ 1.09 $ 1.17 Earnings per share - Diluted 0.33 0.23 1.08 1.16 Cash dividends declared per share 0.15 0.14 0.45 0.40 Book value per share (d) 22.57 20.97 22.57 20.97 Tangible book value per share (d)(e) $ 15.55 $ 14.23 $ 15.55 $ 14.23 Weighted-average number of shares outstanding - Basic 12,632,341 10,589,126 11,348,625 10,574,130 Weighted-average number of shares outstanding - Diluted 12,765,880 10,692,555 11,464,020 10,664,999 Shares outstanding at end of period 14,150,279 10,596,797 14,150,279 10,596,797 (a) Non-interest expense (less intangible asset amortization) as a percentage of fully tax-equivalent net interest income plus non-interest income (excluding gains or losses on investment securities and asset disposals and other transactions). (b) These amounts represent non-GAAP financial measures since they exclude the provision for (recovery of) loan losses and all gains and losses included in earnings. Additional information regarding the calculation of these measures can be found later in this section under the caption "Pre-Provision Net Revenue". (c) Nonperforming loans include loans 90 days past due and accruing, renegotiated loans and nonaccrual loans. Nonperforming assets include nonperforming loans and other real estate owned. (d) Data presented as of the end of the period indicated. (e) These amounts represent non-GAAP financial measures since they exclude the balance sheet impact of intangible assets acquired through acquisitions on both total stockholders' equity and total assets. Additional information regarding the calculation of these measures can be found later in this discussion under the caption "Capital/Stockholders' Equity". 22-------------------------------------------------------------------------------- Table of Contents Forward-Looking Statements Certain statements in this Form 10-Q, which are not historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act , Section 21E of the Exchange Act, and the Private Securities Litigation Reform Act of 1995. Words such as "anticipate", "estimates", "may", "feels", "expects", "believes", "plans", "will", "would", "should", "could" and similar expressions are intended to identify these forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially. Factors that might cause such a difference include, but are not limited to: (1) the success, impact, and timing of the implementation of Peoples' business strategies, including the successful integration of recently completed acquisitions and the expansion of consumer lending activity; (2) Peoples' ability to integrate the Midwest and Ohio Heritage acquisitions and any future acquisitions, including the pending merger of North Akron into Peoples Bank, may be unsuccessful, or may be more difficult, time-consuming or costly than expected; (3) Peoples' ability to obtain governmental approvals of the proposed merger of Peoples with NB&T on the proposed terms andschedule, and approval of the merger by the shareholders of Peoples or of NB&T may be unsuccessful; (4) local, regional, national and international economic conditions and the impact they may have on Peoples and its customers, and Peoples' assessment of the impact, which may be different thananticipated; (5) competitive pressures among financial institutions or from non-financial institutions may increase significantly,including product and pricing pressures, third-party relationships and revenues, and Peoples' ability to attract, develop and retain qualified professionals; (6) changes in the interest rate environment due to economic conditions and/or the fiscal policies of the U.S. government and Board of Governors of the Federal Reserve System ("Federal Reserve Board"), which may adversely impact interest rates, interest margins and interest rate sensitivity; (7) changes in prepayment speeds, loan originations, levels of nonperforming assets, delinquent loans and charge-offs, which may be less favorable than expected and adversely impact the amount of interest income generated; (8) adverse changes in the economic conditions and/or activities, including, but not limited to, impacts from the implementation of the Budget Control Act of 2011 and the American TaxpayerRelief Act of 2012, as well as continuing economic uncertainty in the U.S., the European Union, and other areas, which could decrease sales volumes and increase loan delinquencies and defaults; (9) legislative or regulatory changes or actions, including in particular the Dodd-Frank Wall Street Reform and ConsumerProtection Act of 2010 and the regulations promulgated and to bepromulgated thereunder by the Office of the Comptroller of the Currency, the Federal Reserve Board and the Consumer Financial Protection Bureau, which may subject Peoples, its subsidiaries, or one or more acquired companies to a variety of new and more stringent legal and regulatory requirements which adversely affect theirrespective businesses; (10) deterioration in the credit quality of Peoples' loan portfolio, which may adversely impact the provision for loan losses; (11) changes in accounting standards, policies, estimates or procedures which may adversely affect Peoples' reported financialcondition or results of operations; (12) Peoples' assumptions and estimates used in applying critical accounting policies, which may prove unreliable, inaccurate or not predictive of actual results; (13) adverse changes in the conditions and trends in the financial markets, including political developments, which may adversely affect the fair value of securities within Peoples' investment portfolio, the interest rate sensitivity of Peoples'consolidated balance sheet, and the income generated by Peoples' trust and investment activities; (14) Peoples' ability to receive dividends from its subsidiaries; (15) Peoples' ability to maintain required capital levels and adequate sources of funding and liquidity; (16) the impact of new minimum capital thresholds established as a part of the implementation of Basel III; 23-------------------------------------------------------------------------------- Table of Contents (17) the impact of larger or similar sized financial institutions encountering problems, which may adversely affect the banking industry and/or Peoples' business generation and retention, funding and liquidity; (18) the costs and effects of regulatory and legal developments, including the outcome of potential regulatory or othergovernmental inquiries and legal proceedings and results of regulatory examinations; (19) Peoples' ability to secure confidential information through the use of computer systems and telecommunications networks, including those of Peoples' third-party vendors and other service providers, may prove inadequate, which could adversely affect customer confidence in Peoples and/or result in Peoples incurring a financial loss; (20) the overall adequacy of Peoples' risk management program; (21) the impact on Peoples' businesses, as well as on the risks described above, of various domestic or international military or terrorist activities or conflicts; and (22) other risk factors relating to the banking industry or Peoples as detailed from time to time in Peoples' reports filed with the Securities and Exchange Commission ("SEC"), including those risk factors included in the disclosures under the heading "ITEM 1A. RISK FACTORS" of Peoples' 2013 Form 10-K. All forward-looking statements speak only as of the filing date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements. Although management believes the expectations in these forward-looking statements are based on reasonable assumptions within the bounds of management's knowledge of Peoples' business and operations, it is possible that actual results may differ materially from these projections. Additionally, Peoples undertakes no obligation to update these forward-looking statements to reflect events or circumstances after the filing date of this Form 10-Q or to reflect the occurrence of unanticipated events except as may be required by applicable legal requirements. Copies of documents filed with the SEC are available free of charge at the SEC's website at www.sec.gov and/or from Peoples' website - www.peoplesbancorp.com under the "Investor Relations" section. This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements, and Notes thereto, contained in Peoples' 2013 Form 10-K, as well as the Unaudited Consolidated Financial Statements, Notes to the Unaudited Consolidated Financial Statements, ratios, statistics and discussions contained elsewhere in this Form 10-Q. Business Overview The following discussion and analysis of Peoples' Unaudited Consolidated Financial Statements is presented to provide insight into management's assessment of the financial condition and results of operations. Peoples offers diversified financial products and services through 55 financial service locations and 54 ATMs in northeastern, central and southeastern Ohio, west central West Virginia and northeastern Kentucky through its financial service units - Peoples Bank and Peoples Insurance Agency, LLC ("Peoples Insurance"), a subsidiary of Peoples Bank. Peoples Bank is subject to regulation and examination primarily by the OCC and secondarily by the Federal Reserve Board and the Federal Deposit Insurance Corporation (the "FDIC"). Peoples Insurance is subject to regulation by the Ohio Department of Insurance and the state insurance regulatory agencies of those states in which it may do business. Peoples' products and services include traditional banking products, such as deposit accounts, lending products and trust services. Peoples provides services through traditional offices, ATMs, and telephone and internet-based banking. Peoples also offers a complete array of insurance products and makes available custom-tailored fiduciary and wealth management services. Brokerage services are offered by Peoples exclusively through an unaffiliated registered broker-dealer. Critical Accounting Policies The accounting and reporting policies of Peoples conform to US GAAP and to general practices within the financial services industry. The preparation of the financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could materially differ from those estimates. Management has identified the accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to understanding Peoples' Unaudited Consolidated Financial Statements, and Management's Discussion and Analysis at September 30, 2014, which were unchanged from the policies disclosed in Peoples' 2013 Form 10-K. Summary of Recent Transactions and Events The following is a summary of recent transactions and events that have impacted or are expected to impact Peoples' results of operations or financial condition: 24-------------------------------------------------------------------------------- Table of Contents • On August 7, 2014, Peoples announced the completion of the Private Equity Issuance and sale of 1,847,826 common shares at $23.00 per share to institutional investors. Peoples received net proceeds of $40.2 million from the sale, and intends to use the proceeds, in part, to fund the cash consideration for the NB&T acquisition. • On August 4, 2014, Peoples entered into the NB&T Agreement. The NB&T Agreement calls for NB&T to merge into Peoples and for NB&T's wholly-owned subsidiary, The National Bank and Trust Company, which operates 22 full-service branches in southwest Ohio, to merge into Peoples Bank. Under the terms of the NB&T Agreement, shareholders of NB&T will receive 0.9319 of Peoples' common shares and $7.75 in cash for each share of NB&T. The NB&T transaction is expected to be completed during the first quarter of 2015, pending adoption of the NB&T Agreement by the shareholders of both NB&T and Peoples, the satisfaction of various closing conditions, including the receipt of all necessary bank regulatory approvals, the accuracy of the representations and warranties of each party (subject to certain exceptions), the performance in all material respects by each party of its obligations under the NB&T Agreement, and other conditions customary for transactions of this type. • On April 21, 2014, Peoples entered into the North Akron Agreement. The North Akron Agreement calls for North Akron, which operates four full-service branches in Akron, Cuyahoga Falls, Munroe Falls and Norton, Ohio, to merge into Peoples Bank. Under the terms of the North Akron Agreement, shareholders of North Akron will receive $7,655 per share, or approximately $20.1 million total value, with 80% of the total consideration to be paid in Peoples' common shares and the remaining 20% to be paid in cash. The exchange ratio for the stock component of the transaction will be determined based on the Peoples' average closing stock price during the 20 consecutive trading days immediately preceding the closing of the transaction. The North Akron transaction is expected to be completed during the fourth quarter of 2014, pending adoption of the North Akron Agreement by the shareholders of North Akron, the satisfaction of various closing conditions, including the accuracy of the representations and warranties of each party (subject to certain exceptions), the performance in all material respects by each party of its obligations under the North Akron Agreement, and other conditions customary for transactions of this type. The North Akron transaction is expected to add $0.06 to $0.08 to Peoples' annual earnings per share starting in 2015. One-time acquisition costs will more than offset the incremental earnings in 2014. • At the close of business on August 22, 2014, Peoples completed the acquisition of Ohio Heritage and its full service offices in Coshocton, Newark, Heath, Mount Vernon and New Philadelphia, Ohio. Under the terms of the agreement, Peoples paid $110.00 of consideration per share of Ohio Heritage common stock, or $37.7 million, of which 85% was paid in Peoples' common shares and the remaining 15% in cash. The acquisition added $177.9 million of loans and $175.3 million of deposits at the acquisition date. • At the close of business on May 30, 2014, Peoples completed the acquisition of Midwest and its full service offices in Wellston and Jackson, Ohio. Under the terms of the agreement, Peoples paid $65.50 of consideration per share of Midwest common stock, or $12.6 million, of which 50% was paid in cash and the remaining 50% in Peoples' common shares. The acquisition added $59.7 million of loans and $78.1 million of deposits at the acquisition date. • At the close of business on October 11, 2013, Peoples Bank completed the acquisition of Ohio Commerce Bank ("Ohio Commerce") and its single full-service office in Beachwood, Ohio. Under the terms of the agreement, Peoples Bank paid $13.75 in cash for each share of Ohio Commerce stock for a total cash consideration of $16.5 million. The acquisition added $96.6 million of loans and $110.9 million of deposits at the acquisition date. • Peoples periodically has taken actions to reduce interest rate exposure within the investment portfolio and the entire balance sheet, which have included the sale of low-yielding investment securities and repayment of high-cost borrowings. These actions included the sale of $68.8 million of investment securities, primarily low or volatile yielding residential mortgage-backed securities, during the first quarter of 2013. Some of the proceeds from these investment sales were reinvested in securities during the first quarter with the remaining reinvested early in the second quarter of 2013. During the first half of 2014, in an effort to reduce the relative size of the portfolio, Peoples used the cash flow generated from the investment portfolio to fund loan growth. • Peoples' net interest income and net interest margin are impacted by changes in market interest rates based upon actions taken by the Federal Reserve Board either directly or through its Open Market Committee. These actions include changing its target Federal Funds Rate (the interest rate at which banks lend money to each other), Discount Rate (the interest rate charged to banks for money borrowed from the Federal Reserve Bank) and longer-term market interest rates (primarily U.S. Treasury securities). Longer-term market interest rates also are affected by the demand for U.S. Treasury securities. The resulting changes in the yield curve slope have a direct impact on reinvestment rates for Peoples' earning assets. 25-------------------------------------------------------------------------------- Table of Contents • The Federal Reserve Board has maintained its target Federal Funds Rate at a historically low level of 0% to 0.25% since December 2008 and has maintained the Discount Rate at 0.75% since December 2010. The Federal Reserve Board has indicated the possibility these short-term rates could start to be raised as early as 2015. • From late 2008 until year-end 2012, the Federal Reserve Board took various actions to lower longer-term market interest rates as a means of stimulating the economy - a policy commonly referred to as "quantitative easing". These actions included the buying and selling of mortgage-backed and other debt securities through its open market operations. In December 2013, the Federal Reserve Board announced plans to taper its quantitative easing efforts. As a result, the slope of the U.S. Treasury yield curve has fluctuated significantly. Substantial flattening occurred in late 2008, in mid-2010 and early third quarter of 2011 through 2012, while moderate steepening occurred in the second half of 2009, late 2010 and mid-2013. The curve has remained relatively steep since mid-2013, primarily as a reaction to the Federal Reserve Board's announcement of a reduction in monthly asset purchases and generally improving economic conditions. The impact of these transactions and events, where material, is discussed in the applicable sections of this Management's Discussion and Analysis. EXECUTIVE SUMMARY Net income for the quarter ended September 30, 2014 was $4.2 million, or $0.33 per diluted share, compared to $2.5 million and $0.23 per diluted share a year ago, and $3.5 million or $0.32 per diluted share in the second quarter of 2014. On a year-to-date basis, net income was $12.5 million or $1.08 per diluted share in the nine months of 2014 compared to $12.5 million or $1.16 per diluted share for the same period in 2013. The higher earnings in the third quarter of 2014, compared to the linked quarter were driven primarily by the recovery of loan losses recorded. Compared to the prior year third quarter, net income increased due to higher net interest income and the recognition of income tax expense associated with the surrender of bank owned life insurance completed in 2013. Peoples' recovery of loan losses for the three months ended September 30, 2014 was $380,000, compared to $919,000 during the three months ended September 30, 2013 and provision for loan losses of $583,000 for the three months ended June 30, 2014. For the nine months ended September 30, 2014, provision for loan losses was $211,000 compared to recoveries of loan losses of $3.4 million in 2013. The recovery of loan losses in the third quarter of 2014 was primarily due to decreased criticized assets and a large recovery on a loan previously charged-off. Net recoveries for the third quarter of 2014 were $0.6 million compared to net recoveries of $0.7 million in the third quarter of 2013 and net charge-offs of $0.1 million in the second quarter of 2014. Asset quality metrics remained favorable during the third quarter of 2014. Net interest income was $17.9 million in the third quarter of 2014, compared to $13.7 million for the third quarter of 2013, while net interest margin was 3.46% and 3.23%, respectively. For the nine months ended September 30, 2014, net interest income was $49.5 million, compared to $39.8 million in 2013. The improvement was driven by an increase in earning assets due to higher loan balances, stability in the asset yields, changes in the asset mix, a reduction in funding costs and accretion income from the acquisitions completed to date. The accretion income from the completed acquisitions added 12 basis points to net interest margin in the third quarter of 2014 and 9 basis points year-to-date. For the third quarter of 2014, total non-interest income was relatively flat compared to the linked quarter and 3% higher than the prior year third quarter. For the nine months ended September 30, 2014, total non-interest income increased 7% compared to 2013, largely due to an increase in insurance contingent income. Trust and investment income contributed to the growth for both the third quarter of 2014 compared to the linked quarter and year-to-date, and was up 7% and 8%, respectively. Mortgage banking income continues to be pressured as refinancing activity has declined in response to the higher long-term interest rates, leading to a $26,000 decline compared to the prior year third quarter and a $571,000 decrease year-to-date. Non-interest expenses were 11% higher than the linked quarter and 29% higher than the prior year third quarter. Year-to-date, non interest expenses grew 22% compared to 2013. The increase over the linked quarter was primarily driven by increases in net occupancy and equipment, and salaries and employee benefits. In addition, Peoples recognized acquisition-related expenses of $1.5 million in the third quarter of 2014, compared to $1.3 million in the linked quarter, consisting primarily of deconversion costs, and professional and legal fees. Compared to the prior year third quarter and year-to-date periods, salaries and employee benefits increased 25% due to increases in full-time equivalent employees. Pension settlement charges during the nine months of 2014 were $1.4 million and were $264,000 in 2013. At September 30, 2014, total assets were $2.43 billion, up $374.7 million from year-end 2013. This increase was primarily the result of the Midwest and Ohio Heritage acquisitions, coupled with organic loan growth of $91.5 million since December 31, 2013. The allowance for loan losses was $17.6 million, or 1.17% of loans (net of deferred fees and costs), compared to $17.1 million and 1.43% at December 31, 2013. The acquired loan balances from Ohio Heritage and Midwest did not require an allowance at September 30, 2014, which caused a reduction in the September 30, 2014 allowance for loan losses as a percent of total loans ratio, compared to year-end 2013. Total liabilities were $2.11 billion at September 30, 2014, up $276.9 million since year-end 2013. Retail deposit balances grew 19%, or $290.2 million, since year-end 2013, primarily driven by the deposits acquired from Midwest and Ohio Heritage. Non-interest bearing deposits increased 22% or $90.4 million from December 31, 2013 primarily due to acquisitions and higher than normal deposit balances for two commercial customers. Peoples continues to focus on its strategy of reducing high-cost funding with increases in low-cost core deposits. 26-------------------------------------------------------------------------------- Table of Contents At September 30, 2014, total stockholders' equity was $319.3 million, up $97.8 million since December 31, 2013. During the third quarter of 2014, Peoples issued $32.0 million of common shares in consideration for the Ohio Heritage acquisition, and $40.2 million of common shares in connection with the Private Equity Issuance. Regulatory capital ratios remained significantly higher than "well capitalized" minimums. Peoples' Tier 1 Common Capital ratio remained stable at 14.53% at September 30, 2014, versus 12.42% at December 31, 2013, while the Total Risk-Based Capital ratio was 15.73% versus 13.78% at December 31, 2013. In addition, Peoples' tangible equity to tangible asset ratio was 9.43% and tangible book value per share was $15.55 at September 30, 2014, versus 7.26% and $13.57 at December 31, 2013, respectively. RESULTS OF OPERATIONS Net Interest Income Net interest income, the amount by which interest income exceeds interest expense, remains Peoples' largest source of revenue. The amount of net interest income earned by Peoples each quarter is affected by various factors, including changes in market interest rates due to the Federal Reserve Board's monetary policy, the level and degree of pricing competition for both loans and deposits in Peoples' markets, and the amount and composition of Peoples' earning assets and interest-bearing liabilities. The following tables detail Peoples' average balance sheets for the periods presented: For the Three Months Ended September 30, 2014 June 30, 2014 September 30, 2013 (Dollars in thousands) Average Balance Income/ Expense Yield/Cost Average Balance Income/ Expense Yield/Cost Average Balance Income/ Expense Yield/Cost Short-term investments $ 16,401 $ 5 0.12 % $ 7,076 $ (44 ) (2.49 )% $ 5,914 $ 22 1.41 % Other long-term 1,785 - - % 2,170 2 0.37 % - - - % investments Investment Securities (1): Taxable 631,697 4,227 2.68 % 610,221 4,185 2.74 % 633,335 4,163 2.63 % Nontaxable (2) 63,170 723 4.58 % 58,494 687 4.70 % 50,933 632 4.96 % Total investment 694,867 4,950 2.85 % 668,715 4,872 2.91 % 684,268 4,795 2.80 % securities Loans (3): Commercial real 39,621 442 4.37 % 53,615 514 3.79 % 35,134 382 4.25 % estate, construction Commercial real 501,598 5,766 4.50 % 465,723 5,269 4.48 % 382,242 4,659 4.77 % estate, other Commercial and 254,786 2,883 4.43 % 240,770 2,691 4.42 % 184,024 1,884 4.01 % industrial Residential real 356,870 4,304 4.82 % 286,604 3,311 4.62 % 261,335 2,996 4.59 % estate (4) Home equity lines of 67,629 618 3.66 % 60,349 562 3.72 % 53,072 500 3.77 % credit Consumer 174,303 2,018 4.59 % 155,457 1,771 4.57 % 126,094 1,579 4.97 % Total loans 1,394,807 16,031 4.54 % 1,262,518 14,118 4.45 % 1,041,901 12,000 4.54 % Less: Allowance for (17,595 ) (17,126 ) (17,670 ) loan losses Net loans 1,377,212 16,031 4.59 % 1,245,392 14,118 4.51 % 1,024,231 12,000 4.64 % Total earning assets 2,090,265 20,986 3.97 % 1,923,353 18,948 3.92 % 1,714,413 16,817 3.89 % Intangible assets 87,877 77,917 71,517 Other assets 99,723 89,681 105,802 Total assets $ 2,277,865 $ 2,090,951 $ 1,891,732 27-------------------------------------------------------------------------------- Table of Contents For the Three Months Ended September 30, 2014 June 30, 2014 September 30, 2013 Income/ Income/ Income/ (Dollars in thousands) Average Balance Expense Yield/Cost Average Balance Expense Yield/Cost Average Balance Expense Yield/Cost Deposits: Savings accounts $ 253,328 $ 35 0.05 % $ 230,431 $ 31 0.05 % $ 199,592 $ 27 0.05 % Governmental deposit 179,684 121 0.27 % 159,476 113 0.28 % 153,085 142 0.37 % accounts Interest-bearing 148,611 31 0.08 % 138,745 29 0.08 % 124,093 25 0.08 % demand accounts Money market accounts 287,866 117 0.16 % 268,480 107 0.16 % 226,453 86 0.15 % Brokered deposits 40,508 381 3.73 % 42,976 382 3.57 % 49,810 464 3.70 % Retail certificates of deposit 385,222 829 0.85 % 356,286 803 0.90 % 343,549 930 1.07 % Total interest-bearing 1,295,219 1,514 0.46 % 1,196,394 1,465 0.49 % 1,096,582 1,674 0.61 % deposits Borrowed Funds: Short-term FHLB advances 24,724 17 0.27 % 56,341 14 0.10 % 62,500 14 0.09 % Retail repurchase agreements 68,049 29 0.17 % 55,612 23 0.17 % 38,599 14 0.16 % Total short-term borrowings 92,773 46 0.20 % 111,953 37 0.13 % 101,099 28 0.11 % Long-term FHLB advances 78,766 615 3.10 % 62,108 523 3.38 % 63,874 544 3.38 % Wholesale repurchase agreements 40,000 371 3.71 % 40,000 367 3.67 % 40,000 371 3.71 % Other borrowings 16,748 161 3.76 % 17,943 179 3.95 % 21,524 216 3.93 % Total long-term borrowings 135,514 1,147 3.36 % 120,051 1,069 3.56 % 125,398 1,131 3.58 % Total borrowed funds 228,287 1,193 2.08 % 232,004 1,106 1.91 % 226,497 1,159 2.03 % Total interest-bearing 1,523,506 2,707 0.71 % 1,428,398 2,571 0.72 % 1,323,079 2,833 0.85 % liabilities Non-interest-bearing deposits 449,177 405,282 325,129 Other liabilities 21,161 21,103 26,795 Total liabilities 1,993,844 1,854,783 1,675,003 Total stockholders' equity 284,021 236,168 216,729 Total liabilities and stockholders' equity $ 2,277,865 $ 2,090,951 $ 1,891,732 Interest rate spread $ 18,279 3.26 % $ 16,377 3.20 % $ 13,984 3.04 % Net interest margin 3.46 % 3.39 % 3.23 % 28-------------------------------------------------------------------------------- Table of Contents For the Nine Months Ended September 30, 2014 September 30, 2013 Income/ Income/ (Dollars in thousands) Average Balance Expense Yield/Cost Average Balance Expense Yield/Cost Short-term investments $ 10,213 $ (19 ) (0.24 )% $ 18,682 $ 65 0.47 % Other long-term investments 2,068 5 0.32 % - - - % Investment Securities (1): Taxable 621,818 12,797 2.74 % 649,345 12,625 2.59 % Nontaxable (2) 57,885 2,049 4.72 % 50,051 1,820 4.85 % Total investment securities 679,703 14,846 2.91 % 699,396 14,445 2.75 % Loans (3): Commercial real estate, 48,314 1,454 3.97 % 31,116 1,027 4.35 % construction Commercial real estate, other 473,983 16,150 4.49 % 381,553 13,486 4.66 % Commercial and industrial 244,165 8,144 4.40 % 182,481 5,531 4.00 % Residential real estate (4) 305,053 10,684 4.67 % 249,007 8,976 4.81 % Home equity lines of credit 62,697 1,726 3.67 % 51,413 1,509 3.91 % Consumer 157,111 5,403 4.60 % 116,796 4,541 5.20 % Total loans 1,291,323 43,561 4.47 % 1,012,366 35,070 4.59 % Less: Allowance for loan (17,318 ) (18,102 ) losses Net loans 1,274,005 43,561 4.53 % 994,264 35,070 4.68 % Total earning assets 1,965,989 58,393 3.94 % 1,712,342 49,580 3.84 % Intangible assets 81,099 70,868 Other assets 93,352 122,371 Total assets $ 2,140,440 $ 1,905,581 Deposits: Savings accounts $ 235,017 $ 97 0.06 % $ 196,508 $ 78 0.05 % Governmental deposit accounts 162,851 357 0.29 % 148,901 512 0.46 % Interest-bearing demand 141,503 88 0.08 % 125,009 75 0.08 % accounts Money market accounts 278,288 335 0.16 % 260,180 275 0.14 % Brokered deposits 43,581 1,199 3.68 % 51,949 1,408 3.62 % Retail certificates of deposit 367,412 2,472 0.90 % 358,307 3,063 1.14 % Total interest-bearing 1,228,652 4,548 0.49 % 1,140,854 5,411 0.63 % deposits Borrowed Funds: Short-term FHLB advances 48,123 47 0.16 % 33,542 23 0.16 % Retail repurchase agreements 54,357 67 0.13 % 34,662 40 0.10 % Total short-term borrowings 102,480 114 0.15 % 68,204 63 0.13 % Long-term FHLB advances 67,811 1,660 3.27 % 64,214 1,628 3.39 % Wholesale repurchase agreements 40,000 1,100 3.67 % 40,000 1,100 3.67 % Other borrowings 17,934 528 3.88 % 22,690 678 3.94 % Total long-term borrowings 125,745 3,288 3.49 % 126,904 3,406 3.58 % Total borrowed funds 228,225 3,402 1.99 % 195,108 3,469 2.37 % Total interest-bearing 1,456,877 7,950 0.73 % 1,335,962 8,880 0.89 % liabilities Non-interest-bearing deposits 413,543 323,733 Other liabilities 20,866 24,447 Total liabilities 1,891,286 1,684,142 Total stockholders' equity 249,154 221,439 Total liabilities and stockholders' equity $ 2,140,440 $ 1,905,581 Interest rate spread $ 50,443 3.21 % $ 40,700 2.95 % Net interest margin 3.40 % 3.15 % 29-------------------------------------------------------------------------------- Table of Contents (1) Average balances are based on carrying value. (2) Interest income and yields are presented on a fully tax-equivalent basis using a 35% federal statutory tax rate. (3) Average balances include nonaccrual and impaired loans. Interest income includes interest earned on nonaccrual loans prior to the loans being placed on nonaccrual status. Loan fees included in interest income were immaterial for all periods presented. (4) Loans held for sale are included in the average loan balance listed. Related interest income on loans originated for sale prior to the loan being sold is included in loan interest income. Net interest margin, which is calculated by dividing fully tax-equivalent ("FTE") net interest income by average interest-earning assets, serves as an important measurement of the net revenue stream generated by the volume, mix and pricing of earning assets and interest-bearing liabilities. FTE net interest income is calculated by increasing interest income to convert tax-exempt income earned on obligations of states and political subdivisions to the pre-tax equivalent of taxable income using a 35% federal statutory tax rate. The following table details the calculation of FTE net interest income: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Net interest income, as $ 17,935 $ 16,045 reported $ 13,676 $ 49,460 $ 39,806 Taxable equivalent adjustments 344 332 308 983 894 Fully tax-equivalent net $ 18,279 $ 16,377 $ 13,984 $ 50,443 $ 40,700 interest income 30-------------------------------------------------------------------------------- Table of Contents The following table provides an analysis of the changes in FTE net interest income: Nine Months Ended September 30, 2014 Three Months Ended September 30, 2014 Compared to Compared to (Dollars in thousands) June 30, 2014 September 30, 2013 September 30, 2013Increase (decrease) in: Rate Volume Total (1) Rate Volume Total (1) Rate Volume Total (1) INTEREST INCOME: Short-term investments $ 227 $ (178 ) $ 49 $ (105 ) $ 88 $ (17 ) $ (65 ) $ (19 ) $ (84 ) Other long-term (2 ) - (2 ) - - - - 5 5 investments Investment Securities: (2) Taxable (464 ) 506 42 131 (67 ) 64 936 (764 ) 172 Nontaxable (98 ) 134 36 (274 ) 365 91 (80 ) 309 229 Total investment income (562 ) 640 78 (143 ) 298 155 856 (455 ) 401 Loans: Commercial real estate, 363 (435 ) (72 ) 10 50 60 (147 ) 574 427 construction Commercial real estate, 30 467 497 (1,584 ) 2,691 1,107 (770 ) 3,433 2,663 other Commercial and 5 187 192 215 784 999 600 2,014 2,614 industrial Residential real estate 151 842 993 163 1,145 1,308 (412 ) 2,120 1,708 Home equity lines of (65 ) 121 56 (97 ) 215 118 (147 ) 364 217 credit Consumer 12 235 247 (897 ) 1,336 439 (966 ) 1,828 862 Total loan income 496 1,417 1,913 (2,190 ) 6,221 4,031 (1,842 ) 10,333 8,491 Total interest income 159 1,879 2,038 (2,438 ) 6,607 4,169 (1,051 ) 9,864 8,813 INTEREST EXPENSE: Deposits: Savings accounts 1 3 4 1 7 8 3 16 19 Government deposit accounts (34 ) 42 8 (133 ) 112 (21 ) (225 ) 70 (155 ) Interest-bearing demand accounts (2 ) 4 2 1 5 6 3 10 13 Money market accounts 1 9 10 6 25 31 40 20 60 Brokered certificates of 78 (79 ) (1 ) 30 (113 ) (83 ) 34 (243 ) (209 ) deposit Retail certificates of (202 ) 228 26 (626 ) 525 (101 ) (714 ) 123 (591 ) deposit Total deposit cost (158 ) 207 49 (721 ) 561 (160 ) (859 ) (4 ) (863 ) Borrowed funds: Short-term borrowings 51 (42 ) 9 56 (38 ) 18 9 42 51 Long-term borrowings (248 ) 326 78 (252 ) 268 16 (91 ) (27 ) (118 ) Total borrowed funds (197 ) 284 87 (196 ) 230 34 (82 ) 15 (67 ) cost Total interest expense (355 ) 491 136 (917 ) 791 (126 ) (941 ) 11 (930 ) Net interest income $ 514 $ 1,388 $ 1,902 $ (1,521 ) $ 5,816 $ 4,295 $ (110 ) $ 9,853 $ 9,743 (1) The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the dollar amounts of the changes in each. (2) Presented on a fully tax-equivalent basis. Net interest income increased 12% in the third quarter of 2014 compared to the linked quarter and 31% compared to the prior year third quarter. During the third quarter of 2014, net interest income and net interest margin benefited from accretion income of $628,000 related to the completed acquisitions, which added 12 basis points to net interest margin. During the nine months of 2014, Peoples recorded $1.3 million in accretion income related to acquisitions, which added approximately 9 basis points to net interest margin. 31-------------------------------------------------------------------------------- Table of Contents Loan growth from acquisitions and higher loan production continues to benefit net interest income, as annualized organic loan growth during the nine months in 2014 was 11%. Net interest margin also improved due to the additional interest income recognized from loans acquired during 2014. Funding costs have declined during 2014 as Peoples executed its strategy of replacing higher-cost funding with low-cost deposits. Compared to the prior year, funding costs have decreased 15 basis points and increases in balances of low-cost deposits have provided funding for loan growth. Management has not changed its overall balance sheet strategies of reducing the size of the investment portfolio relative to total earning assets and minimizing Peoples' long-term interest rate risk by potentially match funding some of the 2014 loan growth. Peoples continues to focus on reducing high-cost funding with increases in low-cost core deposits. The pending acquisitions could provide management with additional opportunities to make meaningful progress with these balance sheet strategies. Specifically, Peoples could elect to sell some, or all, of the investment securities currently held by the acquired banks and use the proceeds to repay wholesale borrowings. Such action, if taken, would result in a smaller increase in total earning assets and net interest income. Additional information regarding changes in the Unaudited Consolidated Balance Sheets can be found under appropriate captions of the "FINANCIAL CONDITION" section of this discussion. Additional information regarding Peoples' interest rate risk and the potential impact of interest rate changes on Peoples' results of operations and financial condition can be found later in this discussion under the caption "Interest Rate Sensitivity and Liquidity". (Recovery of) Provision for Loan Losses The following table details Peoples' recovery of, or provision for, loan losses: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Provision for checking account overdrafts $ 120 $ 83 $ 131 $ 211 $ 254 (Recovery of) provision for other (500 ) loan losses 500 (1,050 ) - (3,700 ) Net (recovery of) provision for $ (380 ) $ 583 $ (919 ) $ 211 $ (3,446 ) loan losses As a percentage of average gross loans (a) (0.11 )% 0.19 % (0.35 )% 0.02 % (0.46 )% (a) Presented on an annualized basis The recovery of, or provision for, loan losses recorded represents the amount needed to maintain the adequacy of the allowance for loan losses based on management's quarterly analysis of the loan portfolio and procedural methodology that estimates the amount of probable credit losses. This process considers various factors that affect losses, such as changes in Peoples' loan quality, historical loss experience and current economic conditions. The recovery of loan losses recorded during the third quarter of 2014 was primarily due to a decrease in criticized assets and $500,000 recovery recorded on a loan that had previously been charged-off. The provision for loan losses recorded during the second quarter of 2014 was driven mostly by higher loan growth. During 2014, recoveries on loans exceeded charge-offs by $552,000 for the third quarter and $279,000 on a year-to-date basis. In 2013, recoveries on loans surpassed charge-offs by $708,000 in the third quarter and $2.6 million year-to-date. Peoples continued to experience loss trends and levels of criticized loans that were below historical averages. Additional information regarding changes in the allowance for loan losses and loan credit quality can be found later in this discussion under the caption "Allowance for Loan Losses". 32-------------------------------------------------------------------------------- Table of Contents Net Other (Losses) Gains The following table details the other losses and gains recognized by Peoples: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Net gain on OREO $ 9 $ - $ 10 $ 27 $ 86 Net gain on debt extinguishment 67 - - 67 - Net loss on bank premises and equipment (185 ) (187 ) (29 ) (379 ) (116 ) Net other (losses) gains $ (109 ) $ (187 ) $ (19 ) $ (285 ) $ (30 ) The loss on bank premises and equipment recorded during the third quarter of 2014 was due to asset write-offs associated with the Ohio Heritage acquisition. During the third quarter of 2014, Peoples also recognized a gain on debt extinguishment from a restructuring of FHLB advances, and a gain on OREO from the sale of a residential property that was held. The loss recorded during the second quarter of 2014 was due to write-offs associated with the Midwest acquisition and the relocation of banking and insurance offices. The net gain on OREO in the third quarter of 2013 was due to the sale of a commercial property that was held, and the loss on bank premises and equipment was a result of the sale of a banking office and write-down on a closed banking office that was available for sale. Non-Interest Income Insurance income comprised the largest portion of third quarter 2014 non-interest income. The following table details Peoples' insurance income: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Property and casualty insurance commissions $ 2,499 $ 2,709 $ 2,695 $ 7,661 $ 7,571 Performance-based commissions 224 249 125 1,656 710 Life and health insurance 395 393 389 commissions 1,213 844 Credit life and A&H insurance 9 9 19 commissions 25 76 Other fees and charges 42 83 33 173 158 Total insurance income $ 3,169 $ 3,443 $ 3,261 $ 10,728 $ 9,359 The decline in property and casualty insurance commissions during the third quarter of 2014 compared to the linked quarter and prior year third quarter was primarily driven by lower premiums throughout the industry. The increase in life and health insurance commissions through the nine months of 2014 compared to 2013 was the result of acquisitions completed during the second quarter of 2013. The bulk of performance-based commissions typically are recorded annually in the first quarter and are based on a combination of factors, such as loss experience of insurance policies sold, production volumes, and overall financial performance of the individual insurance carriers. Deposit account service charges continued to comprise a sizable portion of Peoples' non-interest income. The following table details Peoples' deposit account service charges: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Overdraft and non-sufficient $ 1,968 $ 1,772 $ 1,993 funds fees $ 5,284 $ 5,330 Account maintenance fees 449 413 346 1,239 947 Other fees and charges 32 42 38 264 202Total deposit account service $ 2,449 $ 2,227 $ 2,377 $ 6,787 $ 6,479 charges The amount of deposit account service charges, particularly fees for overdrafts and non-sufficient funds, is largely dependent on the timing and volume of customer activity. Peoples typically experiences a lower volume of overdraft and non-sufficient funds fees annually in the first quarter attributable to customers receiving income tax refunds, while volumes generally increase in the fourth quarter in connection with the holiday shopping season. Peoples' fiduciary and brokerage revenues continue to be based primarily upon the value of assets under management, with additional income generated from transaction commissions. The following tables detail Peoples' trust and investment income and related assets under management: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Fiduciary $ 1,346 $ 1,434 $ 1,263 $ 4,109 $ 3,745 Brokerage 530 499 488 1,547 1,480Total trust and investment income $ 1,876 $ 1,933 $ 1,751 $ 5,656 $ 5,225 September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Trust assets under management $ 999,822 $ 1,014,865 $ 995,861 $ 1,000,171 $ 994,683 Brokerage assets under management 511,400 513,890 494,246 474,384 449,196 Total managed assets $ 1,511,222 $ 1,528,755 $ 1,490,107 $ 1,474,555 $ 1,443,879 Quarterly average $ 1,520,615 $ 1,505,433 $ 1,479,110 $ 1,455,429 $ 1,417,707 During the third quarter of 2014, managed assets decreased compared to the prior quarter, and resulted in a reduction in fiduciary fees, which are primarily based on managed asset account balances. In recent years, Peoples has added experienced financial advisors in previously underserved market areas, and generated new business and revenue related to retirement plans for which it manages the assets and provides services. The U.S. financial markets experienced a decline in the third quarter of 2014, resulting in a reduction in managed assets. Peoples electronic banking services include ATM and debit cards, direct deposit services, internet banking, and personal electronic device applications, and serve as alternative delivery channels to traditional sales offices for providing services to customers. The growth in electronic banking income during the third quarter of 2014 was primarily due to an increase in the volume of debit card transactions and ATM surcharges. Mortgage banking income decreased significantly from 2013 due to the sale of loans to the secondary market, which is driven by mortgage interest rates available and customers' preference for long-term, fixed-rate loans. Compared to the linked quarter, mortgage banking income was up slightly due to increased sales of loans, and decreased from the prior year third quarter. In the third quarter of 2014, Peoples sold approximately $14.5 million of loans to the secondary market compared to $11.3 million in the second quarter of 2014 and $14 million in the third quarter of 2013. In the nine months of 2014, Peoples sold approximately $33.6 million compared to $60 million in 2013. Non-Interest Expense Salaries and employee benefit costs remain Peoples' largest non-interest expense, accounting for more than half of total non-interest expense. 33-------------------------------------------------------------------------------- Table of Contents The following table details Peoples' salaries and employee benefit costs: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Base salaries and wages $ 7,371 $ 7,037 $ 6,095 $ 20,921 $ 17,593 Sales-based and incentive 2,116 1,587 1,778 compensation 5,206 5,177 Employee benefits 1,344 1,791 1,160 4,895 2,913 Stock-based compensation 428 464 369 1,382 1,052 Deferred personnel costs (344 ) (353 ) (598 ) (1,063 ) (1,681 ) Payroll taxes and other 752 715 554 employment costs 2,359 1,955 Total salaries and employee $ 11,667 $ 11,241 $ 9,358 $ 33,700 $ 27,009 benefit costs Full-time equivalent employees: Actual at end of period 643 576 539 643 539 Average during the period 609 563 544 575 528 For the three months ended September 30, 2014, severance and retention payouts associated with the Ohio Heritage acquisition and salaries for employees retained from the Midwest and Ohio Heritage acquisitions accounted for much of the increase in base salaries and wages compared to the linked quarter. Sales-based and incentive compensation was also higher compared to the linked quarter, and is tied to corporate incentive plans and commission from sales production. Employee benefits declined during the third quarter of 2014 from lower employee medical benefit costs and a reduction in one-time pension settlement costs recognized, compared to the previous quarter. Peoples recognized $361,000 of settlement costs during the third quarter of 2014, compared to $536,000 in the linked quarter and $264,000 in the third quarter of 2013. During the nine months of 2014, Peoples recorded one-time pension settlement costs of $1.4 million compared to $264,000 in the same period in 2013. Given the nature of the pension settlement, it is inherently difficult to estimate the amount or exact timing of future pension settlement charges. Peoples' net occupancy and equipment expense was comprised of the following: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Depreciation $ 773 $ 677 $ 587 $ 2,135 $ 1,944 Repairs and maintenance costs 704 451 404 1,612 1,311 Net rent expense 238 219 269 699 690 Property taxes, utilities and 552 392 377 other costs 1,376 1,176 Total net occupancy and equipment expense $ 2,267 $ 1,739 $ 1,637 $ 5,822 $ 5,121 Net occupancy and equipment expense increased during the third quarter of 2014, mostly due to higher maintenance costs coupled with increases in real estate taxes and utilities in connection with recent acquisitions. During 2014, depreciation expense increased due to acquired assets and recently completed renovations. Seasonal fluctuations occur in the timing of repairs and maintenance costs, such as snow removal, and are generally higher in the first and fourth quarters. Professional fees increased during the third quarter of 2014 due to $514,000 of additional expenses associated with acquisition-related activity, compared to $375,000 in the linked quarter and $49,000 in the prior year. In the nine months of 2014, professional fees increased $541,000 compared to prior year, which was primarily caused by acquisition-related expenses. Electronic banking expense, which is comprised of bankcard and internet-based banking costs, continued to increase in the third quarter and nine months of 2014 compared to prior periods. The primary reasons for the increases were a higher volume of transactions completed by customers, additional services provided and increased debit card compromises at certain large retail companies. Peoples' efficiency ratio, calculated as non-interest expense less amortization of other intangible assets divided by FTE net interest income plus non-interest income, was 77.61% for the third quarter of 2014, higher than the linked quarter of 75.58% and the prior year third quarter of 72.47%. Management continues to target an efficiency ratio in the range of 68% to 70%, absent acquisition-related costs and other one-time expenses, such as pension settlement charges. 34-------------------------------------------------------------------------------- Table of Contents Income Tax Expense For the nine months ended September 30, 2014, Peoples recorded income tax expense of $5.5 million, for an effective tax rate of 30.5%. This effective tax rate represents management's current estimate of the rate for the entire year. In comparison, Peoples recorded income tax expense of $9.2 million for the same period in 2013, for an effective tax rate of 42.5%. During the third quarter of 2013, Peoples recorded an additional $2.2 million income tax expense associated with the surrender of bank owned life insurance. Pre-Provision Net Revenue Pre-provision net revenue ("PPNR") has become a key financial measure used by federal bank regulatory agencies when assessing the capital adequacy of financial institutions. PPNR is defined as net interest income plus non-interest income minus non-interest expense and, therefore, excludes the provision for loan losses and all gains and losses included in earnings. As a result, PPNR represents the earnings capacity that can be either retained in order to build capital or used to absorb unexpected losses and preserve existing capital. The following table provides a reconciliation of this non-GAAP financial measure to the amounts reported in Peoples' consolidated financial statements for the periods presented: Three Months Ended Nine Months Ended September 30, June 30, September 30, September 30, (Dollars in thousands) 2014 2014 2013 2014 2013 Pre-Provision Net Revenue: Income before income taxes $ 5,984 $ 5,057 $ 6,898 $ 17,972 $ 21,669 Add: provision for loan losses - 583 - 211 - Add: net loss on loans held-for-sale and OREO - - - - 5 Add: net loss on securities transactions - - 1 30 1 Add: net loss on other assets 185 187 29 379 118 Less: recovery of loan losses 380 - 919 - 3,446 Less: net gain on debt extinguishment 67 - - 67 - Less: net gain on loans held-for-sale and OREO 9 - 10 27 91 Less: net gain on securities transactions 124 66 - 190 444 Less: gain on other assets - - - - 2 Pre-provision net revenue $ 5,589 $ 5,761 $ 5,999 $ 18,308 $ 17,810 Pre-provision net revenue $ 5,589 $ 5,761 $ 5,999 $ 18,308 $ 17,810 Total average assets 2,277,865 2,090,951 1,891,732 2,140,440 1,905,581 Pre-provision net revenue to total average assets 0.97 % 1.11 % 1.26 % 1.14 % 1.25 % (a) Presented on an annualized basis. During the third quarter of 2014, PPNR declined due to additional costs from acquisition-related activities, higher net occupancy and equipment expense and electronic banking expense. For the nine months ended September 30, 2014, PPNR increased as net interest income and non-interest income growth outpaced increases in acquisition-related costs incurred during the year. FINANCIAL CONDITION Cash and Cash Equivalents At September 30, 2014, Peoples' interest-bearing deposits in other banks increased compared to December 31, 2013. These balances included $10.6 million of excess cash reserves being maintained at the Federal Reserve Bank at September 30, 2014, compared to $14.2 million at December 31, 2013. The amount of excess cash reserves maintained is dependent upon Peoples' daily liquidity position, which is driven primarily by changes in deposit and loan balances. 35-------------------------------------------------------------------------------- Table of Contents Through nine months of 2014, Peoples' total cash and cash equivalents increased $12.2 million, as cash provided by operating activities totaling $19.4 million and cash provided by financing activities of $14.7 million, was partially offset by cash used in investing activities of $22 million. Within Peoples' investing activities, the $68 million of net loan growth exceeded the $34.4 million generated by activities related to available-for-sale securities. Peoples' financing activities included $123.3 million of cash generated by increases in non-interest-bearing deposits, advances from long-term borrowings and proceeds from issuance of common shares, while $103.7 million of cash was used to decrease short-term borrowings, long-term borrowings, and interest-bearing deposits. In comparison, through nine months of 2013, Peoples' total cash and cash equivalents decreased $11.9 million, as cash used in Peoples' investing and financing activities exceeded the $32.1 million of cash generated by operating activities. Investing activities used $39.8 million of cash to fund the $68.7 million net loan growth, while proceeds from the BOLI Surrender contributed $42.8 million. Within Peoples' financing activities, decreases in deposits of $54.4 million were funded by additional short-term borrowings of $59.1 million. Further information regarding the management of Peoples' liquidity position can be found later in this discussion under "Interest Rate Sensitivity and Liquidity." Investment Securities The following table provides information regarding Peoples' investment portfolio: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Available-for-sale securities, at fair value: Obligations of: U.S. Treasury and government agencies $ 7 $ 19 $ 19 $ 20 $ 22 U.S. government sponsored agencies 8,689 - 295 319 356 States and political subdivisions 64,048 61,281 51,668 50,962 51,061 Residential mortgage-backed securities 518,159 491,628 500,516 510,097 519,387 Commercial mortgage-backed securities 27,542 27,746 26,750 32,304 33,135 Bank-issued trust preferred securities 8,194 8,132 7,995 7,829 7,868 Equity securities 5,188 4,997 4,854 4,577 4,207 Total fair value $ 631,827 $ 593,803 $ 592,097 $ 606,108 $ 616,036 Total amortized cost $ 631,500 $ 592,954 $ 598,445 $ 621,126 $ 623,024 Net unrealized gain (loss) $ 327 $ 849 $ (6,348 ) $ (15,018 ) $ (6,988 ) Held-to-maturity securities, at amortized cost: Obligations of: States and political subdivisions $ 3,843 $ 3,845 $ 3,848 $ 3,850 $ 3,853 Residential mortgage-backed securities 37,316 37,766 37,151 37,536 38,046 Commercial mortgage-backed securities 7,724 7,765 7,804 7,836 7,859 Total amortized cost $ 48,883 $ 49,376 $ 48,803 $ 49,222 $ 49,758 Total investment portfolio: Amortized cost $ 680,383 $ 642,330 $ 647,248 $ 670,348 $ 672,782 Carrying value $ 680,710 $ 643,179 $ 640,900 $ 655,330 $ 665,794 In the third quarter of 2014, Peoples acquired investment securities in the Ohio Heritage acquisition, and sold a portion of those securities, adding approximately $13.9 million of available-for-sale securities to the investment portfolio. Other increases in the available-for-sale portfolio compared to the linked quarter were due to the addition of residential mortgage-backed securities. At September 30, 2014, the investment portfolio was 29% of total assets compared to 33% at year-end and 36% a year ago. In recent quarters, Peoples has maintained the size of the held-to-maturity securities portfolio, for which the unrealized gain or loss does not directly impact stockholders' equity, in contrast to the impact from the available-for-sale securities portfolio. Peoples' investment in residential and commercial mortgage-backed securities largely consists of securities either guaranteed by the U.S. government or issued by U.S. government sponsored agencies, such as Fannie Mae and Freddie Mac. 36-------------------------------------------------------------------------------- Table of Contents The remaining portions of Peoples' mortgage-backed securities consist of securities issued by other entities, including other financial institutions, which are not guaranteed by the U.S. government. The amount of these "non-agency" securities included in the residential mortgage-backed securities totals above was as follows: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Total fair value $ 15,748 $ 16,864 $ 21,351 $ 23,446 $ 25,573 Total amortized cost $ 15,191 $ 16,268 $ 20,562 $ 22,926 $ 24,430 Net unrealized gain $ 557 $ 596 $ 789 $ 520 $ 1,143 Management continues to reinvest the principal runoff from the non-agency securities into U.S agency investments, which has accounted for the continued decline in the fair value of these securities. At September 30, 2014, Peoples' non-agency portfolio consisted entirely of first lien residential mortgages, with nearly all of the underlying loans in these securities originated prior to 2004 and possessing fixed interest rates. Management continues to monitor the non-agency portfolio closely for leading indicators of increasing stress and will continue to be proactive in taking actions to mitigate such risk when necessary. Loans The following table provides information regarding outstanding loan balances: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Gross portfolio loans: Commercial real estate, construction $ 25,877 $ 56,421 $ 55,935 $ 47,539 $ 39,969 Commercial real estate, other 545,592 463,734 458,580 450,170 374,953 Commercial real estate 571,469 520,155 514,515 497,709 414,922 Commercial and industrial 261,544 254,561 233,329 232,754 192,238 Residential real estate 412,807 314,190 268,794 268,617 262,602 Home equity lines of credit 74,762 61,838 60,319 60,076 55,341 Consumer 180,100 163,326 143,541 135,018 127,785 Deposit account overdrafts 2,669 5,282 6,008 2,060 4,277 Total portfolio loans $ 1,503,351 $ 1,319,352 $ 1,226,506 $ 1,196,234 $ 1,057,165 Percent of loans to total loans: Commercial real estate, 1.7 % construction 4.3 % 4.6 % 4.0 % 3.8 % Commercial real estate, 36.3 % other 35.1 % 37.4 % 37.6 % 35.5 % Commercial real estate 38.0 % 39.4 % 42.0 % 41.6 % 39.3 % Commercial and industrial 17.4 % 19.3 % 19.0 % 19.5 % 18.2 % Residential real estate 27.4 % 23.8 % 21.9 % 22.5 % 24.8 % Home equity lines of credit 5.0 % 4.7 % 4.9 % 5.0 % 5.2 % Consumer 12.0 % 12.4 % 11.7 % 11.3 % 12.1 % Deposit account overdrafts 0.2 % 0.4 % 0.5 % 0.1 % 0.4 % Total percentage 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Residential real estate loans being serviced for others $ 343,659 $ 341,893 $ 340,057 $ 341,183 $ 339,557 Gross portfolio loans increased $184 million, or 14% from the prior quarter due to organic growth and the Ohio Heritage acquisition. At September 30, 2014, the loans acquired from Ohio Heritage added approximately $50.3 million of commercial real estate loans, $9.3 million of commercial and industrial loans, $96.3 million of residential real estate loans, $10.3 million of home equity lines of credit and $8.6 million of consumer loans after purchase accounting adjustments. Organic loan growth was primarily due to increases in residential real estate, home equity lines of credit and consumer loans, while commercial loan production was mostly offset by payoffs of $35.7 million on five loans during the third quarter of 37-------------------------------------------------------------------------------- Table of Contents 2014. Consumer loan balances, which consist mostly of loans to finance automobile purchases, have continued to increase in recent quarters due largely to Peoples placing greater emphasis on its consumer lending activity. Loan Concentration Peoples categorizes its commercial loans according to standard industry classifications and monitors for concentrations in a single industry or multiple industries that could be impacted by changes in economic conditions in a similar manner. Peoples' commercial lending activities continue to be spread over a diverse range of businesses from all sectors of the economy, with no single industry comprising over 10% of Peoples' total loan portfolio. Loans secured by commercial real estate, including commercial construction loans, continue to comprise the largest portion of Peoples' loan portfolio. The following table provides information regarding the largest concentrations of commercial real estate loans within the loan portfolio at September 30, 2014: Outstanding (Dollars in thousands) Balance Loan Commitments Total Exposure % of Total Commercial real estate, other: Lodging and lodging related $ 52,387 $ - $ 52,387 9.4 % Apartment complexes 78,729 102 78,831 14.2 % Office buildings and complexes: Owner occupied 15,078 263 15,341 2.8 % Non-owner occupied 37,694 883 38,577 6.9 % Total office buildings and complexes 52,772 1,146 53,918 9.7 % Light industrial facilities: Owner occupied 30,867 355 31,222 5.6 % Non-owner occupied 2,273 - 2,273 0.4 % Total light industrial facilities 33,140 355 33,495 6.0 % Retail facilities: Owner occupied 17,629 145 17,774 3.2 % Non-owner occupied 33,354 - 33,354 6.0 % Total retail facilities 50,983 145 51,128 9.2 % Assisted living facilities and nursing homes 45,535 250 45,785 8.2 % Mixed commercial use facilities: Owner occupied 19,915 1,011 20,926 3.8 % Non-owner occupied 18,937 307 19,244 3.4 % Total mixed commercial use facilities 38,852 1,318 40,170 7.2 % Day care facilities - owner occupied 17,961 250 18,211 3.3 % Health care facilities: Owner occupied 5,598 40 5,638 1.0 % Non-owner occupied 15,804 145 15,949 2.9 % Total health care facilities 21,402 185 21,587 3.9 % Restaurant facilities: Owner occupied 15,916 - 15,916 2.9 % Non-owner occupied 1,102 - 1,102 0.2 % Total restaurant facilities 17,018 - 17,018 3.1 % Warehouse facilities 16,006 251 16,257 2.9 % Other 120,807 6,237 127,044 22.9 %Total commercial real estate, other $ 545,592 $ 10,239 $ 555,831 100.0 % 38 -------------------------------------------------------------------------------- Table of Contents Outstanding (Dollars in thousands) Balance Loan Commitments Total Exposure % of Total Commercial real estate, construction: Apartment complexes $ 5,619 $ 18,613 $ 24,232 30.1 % Office buildings and complexes: Owner occupied 71 180 251 0.3 % Non-owner occupied 1,111 3,685 4,796 6.0 % Total office buildings and complexes 1,182 3,865 5,047 6.3 % Assisted living facilities and nursing homes 7,635 6,207 13,842 17.2 % Mixed commercial use facilities: Owner occupied 3,943 5,959 9,902 12.3 % Non-owner occupied 1,077 4,601 5,678 7.1 % Total mixed commercial use facilities 5,020 10,560 15,580 19.4 % Day care facilities - owner occupied 370 2,575 2,945 3.7 % Restaurant facilities - owner occupied 1,420 1,554 2,974 3.7 % Residential property 2,236 5,770 8,006 10.0 % Other 2,395 5,361 7,756 9.6 %Total commercial real estate, construction $ 25,877 $ 54,505 $ 80,382 100.0 % Peoples' commercial lending activities continue to focus on lending opportunities inside its primary and secondary market areas within Ohio, West Virginia and Kentucky. In all other states, the aggregate outstanding balances of commercial loans in each state were less than $4.0 million at both September 30, 2014 and December 31, 2013. Allowance for Loan Losses The amount of the allowance for loan losses at the end of each period represents management's estimate of expected losses from existing loans based upon its quarterly analysis of the loan portfolio. While this process involves allocations being made to specific loans and pools of loans, the entire allowance is available for all losses incurred within the loan portfolio. The following details management's allocation of the allowance for loan losses: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Commercial real estate 10,546 10,267 13,327 13,215 12,826 Commercial and industrial 3,228 3,219 2,130 2,174 2,195 Total commercial 13,774 13,486 15,457 15,389 15,021 Residential real estate 1,765 1,818 782 881 826 Home equity lines of 658 656 credit 329 343 337 Consumer 1,231 1,298 198 316 564 Deposit account overdrafts 128 126 104 136 154 Total allowance for loan $ 17,556 $ 17,384 $ 16,870 $ 17,065 $ 16,902 losses As a percent of loans, net of deferred fees and costs 1.17 % 1.32 % 1.38 % 1.43 % 1.60 % The significant allocations to commercial loans reflect the higher credit risk associated with this type of lending and the size of this loan category in relationship to the entire loan portfolio. During the third quarter of 2014, Peoples' allowance for loan losses was primarily flat compared to the linked quarter, as organic loan growth was offset by declines in criticized assets and additional recoveries recorded during the quarter. The decline in the allowance for loan losses as a percent of loans, net of deferred fees and costs, is primarily a result of loans acquired, for which no allowance for loan losses has been required. Peoples' asset quality continued to remain favorable during 2014. Net charge-offs also remained at or below Peoples' long-term historical rate. These factors had a direct impact on the estimated loss rates used to determine the allocations of allowance for loan losses for commercial loans. The allowance allocated to the residential real estate and consumer loan categories is based upon Peoples' allowance methodology for homogeneous pools of loans. The fluctuations in these allocations have been directionally consistent with the changes in loan quality, loss experience and loan balances in these categories. 39-------------------------------------------------------------------------------- Table of Contents The following table summarizes Peoples' net charge-offs and recoveries: Three Months Ended September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Gross charge-offs: Commercial real estate, construction $ - $ - $ - $ - $ - Commercial real estate, 126 - other - 71 199 Commercial real estate 126 - - 71 199 Commercial and industrial - - 49 33 - Residential real estate 105 135 137 181 218 Home equity lines of 6 25 credit 20 - 160 Consumer 289 250 302 439 301 Deposit account overdrafts 150 91 110 147 135 Total gross charge-offs 676 501 618 871 1,013 Recoveries: Commercial real estate, - - construction - - - Commercial real estate, 905 96 other 112 1,526 1,507 Commercial real estate 905 96 112 1,526 1,507 Commercial and industrial 9 54 5 12 7 Residential real estate 52 79 38 236 39 Home equity lines of 8 6 credit 6 6 7 Consumer 222 167 184 191 125 Deposit account overdrafts 32 30 70 27 36 Total recoveries 1,228 432 415 1,998 1,721 Net charge-offs (recoveries): Commercial real estate, construction - - - - - Commercial real estate, (779 ) other (96 ) (112 ) (1,455 ) (1,308 ) Commercial real estate (779 ) (96 ) (112 ) (1,455 ) (1,308 ) Commercial and industrial (9 ) (54 ) 44 21 (7 ) Residential real estate 53 56 99 (55 ) 179 Home equity lines of (2 ) credit 19 14 (6 ) 153 Consumer 67 83 118 248 176 Deposit account overdrafts 118 61 40 120 99 Total net charge-offs (recoveries) $ (552 ) $ 69 $ 203 $ (1,127 ) $ (708 ) Ratio of net charge-offs (recoveries) to average loans (annualized): Commercial real estate, construction - % - % - % - % - % Commercial real estate, (0.22 )% (0.03 )% other (0.04 )% (0.51 )% (0.50 )% Commercial real estate (0.22 )% (0.03 )% (0.04 )% (0.51 )% (0.50 )% Commercial and industrial - % (0.03 )% 0.02 % 0.01 % - % Residential real estate 0.02 % 0.02 % 0.03 % (0.02 )% 0.07 % Home equity lines of - % 0.01 % credit 0.01 % - % 0.06 % Consumer 0.02 % 0.03 % 0.04 % 0.09 % 0.07 % Deposit account overdrafts 0.03 % 0.02 % 0.01 % 0.04 % 0.04 % Total (0.15 )% 0.02 % 0.07 % (0.39 )% (0.26 )% Peoples recorded a $500,000 recovery during the third quarter of 2014 on a single previously charged-off commercial real estate loan. Peoples' net charge-offs continue to remain well below the long-term historical average of 0.30% to 0.50%. 40 -------------------------------------------------------------------------------- Table of Contents The following table details Peoples' nonperforming assets: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Loans 90+ days past due and accruing: Commercial real estate, other $ 1,406 $ 1,138 $ - $ - $ - Commercial and industrial 279 903 - - 950 Residential real estate 798 1,290 29 37 - Home equity - 39 129 873 1,615 Consumer 1 20 1 - 32 Total 2,484 3,390 159 910 2,597 Nonaccrual loans: Commercial real estate, - construction - 96 96 76 Commercial real estate, other 2,014 1,834 2,913 2,801 3,593 Commercial and industrial 655 806 640 708 323 Residential real estate 2,782 2,945 3,294 2,565 3,012 Home equity 240 256 323 81 61 Consumer - - - 58 60 Total 5,691 5,841 7,266 6,309 7,125 Troubled debt restructurings: Commercial real estate, 96 construction 96 897 916 1,193 Commercial real estate, other 339 1,356 - - - Commercial and industrial - - - - - Residential real estate 465 675 637 650 195 Home equity 35 36 6 6 24 Total 935 2,163 1,540 1,572 1,412Total nonperforming loans (NPLs) 9,110 11,394 8,965 8,791 11,134 Other real estate owned (OREO) Commercial 582 465 465 465 - Residential 463 450 308 428 120 Total 1,045 915 773 893 120 Total nonperforming assets $ 10,155 $ 12,309 $ 9,738 $ 9,684 $ 11,254 (NPAs) NPLs as a percent of total loans 0.60 % 0.86 % 0.73 % 0.73 % 1.05 % NPAs as a percent of total 0.42 % 0.57 % assets 0.47 % 0.47 % 0.59 % NPAs as a percent of total loans 0.67 % 0.93 % and OREO 0.79 % 0.81 % 1.06 % Allowance for loan losses as a percent of NPLs 192.71 % 152.57 % 188.19 % 194.13 % 151.79 % During the third quarter of 2014, loans reported as accruing and 90 days past due decreased due to a payoff of a single relationship of $1.2 million, and was partially offset by loans added from the Ohio Heritage acquisition. The increase in OREO during the third quarter of 2014 was also the result of properties acquired in the Ohio Heritage acquisition. 41-------------------------------------------------------------------------------- Table of Contents Deposits The following table details Peoples' deposit balances: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Interest-bearing deposits: Retail certificates of $ 408,868 $ 373,072 deposit $ 355,345 $ 363,226 $ 334,910 Money market deposit 309,721 268,939 accounts 276,226 275,801 224,400 Governmental deposit 183,213 165,231 accounts 177,590 132,379 151,910 Savings accounts 262,949 244,472 227,695 215,802 196,293 Interest-bearing demand 156,867 142,170 accounts 133,508 134,618 123,966 Total retail 1,321,618 1,193,884 1,121,826 1,031,479 interest-bearing deposits 1,170,364 Brokered certificates of 39,671 40,650 deposits 45,072 49,041 49,620 Total interest-bearing 1,361,289 1,234,534 1,170,867 1,081,099 deposits 1,215,436 Non-interest-bearing 500,330 426,384 deposits 417,629 409,891 356,767 Total deposits $ 1,861,619 $ 1,660,918 $ 1,633,065 $ 1,580,758 $ 1,437,866 During the third quarter of 2014, Peoples completed the acquisition of Ohio Heritage, which included retail certificates of deposits ("CDs") totaling $45.9 million, money market deposit accounts of $93.8 million, governmental deposit accounts of $2.0 million, savings accounts of $18.9 million, interest-bearing demand accounts of $0.6 million and non-interest bearing deposits of $2.2 million at September 30, 2014. Excluding the acquired deposit accounts, retail certificates of deposit and money market deposit accounts declined $63.1 million from June 30, 2014, while non-interest bearing deposits increased $71.7 million or 17%, of which $38.1 million is due to two commercial customers maintaining higher than historical balances. Peoples maintained its deposit strategy of growing low-cost core deposits, such as checking and savings accounts, and reducing its reliance on higher-cost, non-core deposits, such as CDs and brokered deposits. Borrowed Funds The following table details Peoples' short-term and long-term borrowings: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Short-term borrowings: FHLB advances $ - $ 48,000 $ 15,000 $ 71,000 $ 64,000 Retail repurchase agreements 71,897 67,869 53,777 42,590 42,843 Total short-term borrowings 71,897 115,869 68,777 113,590 106,843 Long-term borrowings: FHLB advances 101,890 62,056 62,211 62,679 63,806 National market repurchase 40,000 40,000 agreements 40,000 40,000 40,000 Term note payable (parent 15,564 16,759 17,953 20,340 company) 19,147 Total long-term borrowings 157,454 118,815 120,164 121,826 124,146 Total borrowed funds $ 229,351 $ 234,684 $ 188,941 $ 235,416 $ 230,989 Peoples' short-term FHLB advances generally consist of overnight borrowings being maintained in connection with the management of Peoples' daily liquidity position. As detailed in Note 5 of the Notes to the Consolidated Financial Statements included in this Form 10-Q, an amendment was made to the original Loan Agreement that Peoples entered into in 2012. Peoples is subject to certain covenants imposed by this Amended Loan Agreement, and at September 30, 2014, Peoples was in compliance with the applicable material covenants, as explained in more detail in Note 5 of the Notes to the Consolidated Financial Statements included in this Form 10-Q. 42-------------------------------------------------------------------------------- Table of Contents Capital/Stockholders' Equity During the third quarter of 2014, Peoples issued common shares (representing $32.0 million) in partial consideration for the Ohio Heritage acquisition, and the remaining consideration was paid in cash. Peoples also completed the Private Equity Issuance of common shares which added $40.2 million in common equity. At September 30, 2014, capital levels for both Peoples and Peoples Bank remained substantially higher than the minimum amounts needed to be considered "well capitalized" institutions under banking regulations. These higher capital levels reflect Peoples' desire to maintain strong capital positions to provide greater flexibility to grow the company. The following table details Peoples' actual risk-based capital levels and corresponding ratios: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Capital Amounts: Tier 1 232,720 177,394 170,677 166,217 168,254 Total (Tier 1 and Tier 2) 251,977 196,426 189,145 184,457 184,550 Net risk-weighted assets $ 1,601,664 $ 1,438,683 $ 1,358,691 $ 1,338,811 $ 1,194,016 Capital Ratios: Tier 1 14.53 % 12.33 % 12.56 % 12.42 % 14.09 % Total (Tier 1 and Tier 2) 15.73 % 13.65 % 13.92 % 13.78 % 15.46 % Leverage ratio 10.64 % 8.76 % 8.56 % 8.52 % 9.14 % In addition to traditional capital measurements, management uses tangible capital measures to evaluate the adequacy of Peoples' stockholders' equity. Such ratios represent non-GAAP financial information since their calculation removes the impact of intangible assets acquired through acquisitions on the Unaudited Consolidated Balance Sheets. Management believes this information is useful to investors since it facilitates the comparison of Peoples' operating performance, financial condition and trends to peers, especially those without a similar level of intangible assets to that of Peoples. Further, intangible assets generally are difficult to convert into cash, especially during a financial crisis, and could decrease substantially in value should there be deterioration in the overall franchise value. As a result, tangible equity represents a conservative measure of the capacity for a company to incur losses but remain solvent. The following table reconciles the calculation of these non-GAAP financial measures to amounts reported in Peoples' Unaudited Consolidated Financial Statements: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Tangible Equity: Total stockholders' equity, $ 319,332 $ 244,271 as reported $ 230,576 $ 221,553 $ 222,247 Less: goodwill and other 99,269 79,273 intangible assets 77,288 77,603 71,417 Tangible equity $ 220,063 $ 164,998 $ 153,288 $ 143,950 $ 150,830 Tangible Assets: Total assets, as reported $ 2,433,763 $ 2,163,892 $ 2,078,253 $ 2,059,108 $ 1,919,705 Less: goodwill and other 99,269 79,273 intangible assets 77,288 77,603 71,417 Tangible assets $ 2,334,494 $ 2,084,619 $ 2,000,965 $ 1,981,505 $ 1,848,288 Tangible Book Value per Share: Tangible equity $ 220,063 $ 164,998 $ 153,288 $ 143,950 $ 150,830 Shares outstanding 14,150,279 10,926,436 10,657,569 10,605,782 10,596,797 Tangible book value per share $ 15.55 $ 15.10 $ 14.38 $ 13.57 $ 14.23 Tangible Equity to Tangible Assets Ratio: Tangible equity $ 220,063 $ 164,998 $ 153,288 $ 143,950 $ 150,830 Tangible assets $ 2,334,494 $ 2,084,619 $ 2,000,965 $ 1,981,505 $ 1,848,288 Tangible equity to tangible 9.43 % 7.92 % 7.66 % 7.26 % 8.16 % assets 43-------------------------------------------------------------------------------- Table of Contents The increase in the tangible equity to tangible assets ratio during the third quarter of 2014 compared to the linked quarter was primarily caused by the issuance of equity in the Ohio Heritage acquisition and the Private Equity Issuance. Compared to the third quarter of 2013, increases in stockholders' equity were driven primarily by issuances of equity in connection with acquisitions, the Private Equity Issuance and earnings exceeding dividends, while higher tangible assets were attributable to loan production and acquisitions. Interest Rate Sensitivity and Liquidity While Peoples is exposed to various business risks, the risks relating to interest rate sensitivity and liquidity are major risks that can materially impact future results of operations and financial condition due to their complexity and dynamic nature. The objective of Peoples' asset/liability management ("ALM") function is to measure and manage these risks in order to optimize net interest income within the constraints of prudent capital adequacy, liquidity and safety. This objective requires Peoples to focus on interest rate risk exposure and adequate liquidity through its management of the mix of assets and liabilities, their related cash flows, and the rates earned and paid on those assets and liabilities. Ultimately, the ALM function is intended to guide management in the acquisition and disposition of earning assets, and selection of appropriate funding sources. Interest Rate Risk Interest rate risk ("IRR") is one of the most significant risks arising in the normal course of business of financial services companies like Peoples. IRR is the potential for economic loss due to future interest rate changes that can impact the earnings stream as well as market values of financial assets and liabilities. Peoples' exposure to IRR is due primarily to differences in the maturity or repricing of earning assets and interest-bearing liabilities. In addition, other factors, such as prepayments of loans and investment securities or early withdrawal of deposits, can expose Peoples to IRR and increase interest costs or reduce revenue streams. Peoples has assigned overall management of IRR to its Asset-Liability Committee (the "ALCO"), which has established an IRR management policy that sets minimum requirements and guidelines for monitoring and managing the level and amount of IRR. The methods used by the ALCO to assess IRR remain unchanged from those disclosed in Peoples' 2013 Form 10-K. The following table shows the estimated changes in net interest income and the economic value of equity based upon a standard, parallel shock analysis (dollars in thousands): Increase in Interest Estimated Increase in Rate Net Interest Income Estimated Decrease in Economic Value of Equity (in Basis Points) September 30, 2014 December 31, 2013 September 30, 2014 December 31, 2013 300 $ 7,776 10.9 % $ 5,473 8.9 % $ (59,046 ) (15.0 )% $ (65,867 ) (24.8 )% 200 6,155 8.6 % 4,494 7.3 % (38,337 ) (9.8 )% (46,077 ) (17.4 )% 100 3,836 5.4 % 2,885 4.7 % (17,568 ) (4.5 )% (23,910 ) (9.0 )% At September 30, 2014, Peoples' Unaudited Consolidated Balance Sheet remained positioned for a rising interest rate environment, as illustrated by the potential increase in net interest income shown in the above table. While parallel interest rate shock scenarios are useful in assessing the level of IRR inherent in Peoples' consolidated balance sheet, interest rates typically move in a non-parallel manner, with differences in the timing, direction and magnitude of changes in short-term and long-term interest rates. Thus, any benefit that could occur as a result of the Federal Reserve Board increasing short-term interest rates in future quarters could be offset by an inverse movement in long-term interest rates. Liquidity In addition to IRR management, another major objective of the ALCO is to maintain a sufficient level of liquidity. The methods used by the ALCO to monitor and evaluate the adequacy of Peoples' liquidity position remain unchanged from those disclosed in Peoples' 2013 Form 10-K. At September 30, 2014, Peoples had liquid assets of $235.4 million, which represented 9.0% of total assets and unfunded commitments. This amount exceeded the minimal level of $52.2 million, or 2% of total loans and unfunded commitments, currently required under Peoples' liquidity policy. Peoples also had an additional $39 million of unpledged securities not included in the measurement of liquid assets. Management believes the current balance of cash and cash equivalents and anticipated cash flows from the investment portfolio, along with the availability of other funding sources, will allow Peoples to meet anticipated cash obligations, as well as special needs and off-balance sheet commitments. 44-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Activities and Contractual Obligations Peoples routinely engages in activities that involve, to varying degrees, elements of risk that are not reflected in whole or in part in the Unaudited Consolidated Financial Statements. These activities are part of Peoples' normal course of business and include traditional off-balance sheet credit-related financial instruments, interest rate contracts and commitments to make additional capital contributions in low-income housing tax credit investments. Traditional off-balance sheet credit-related financial instruments continue to represent the most significant off-balance sheet exposure. The following table details the total contractual amount of loan commitments and standby letters of credit: September 30, June 30, March 31, December 31, September 30, (Dollars in thousands) 2014 2014 2014 2013 2013 Home equity lines of credit $ 59,549 $ 50,558 $ 49,918 $ 49,533 $ 45,655 Unadvanced construction loans 54,504 29,396 23,231 30,203 25,923 Other loan commitments 152,503 155,858 136,805 137,661 129,418 Loan commitments 266,556 235,812 209,954 217,397 200,996 Standby letters of credit $ 34,570 $ 33,852 $ 33,555 $ 33,998 $ 34,804 Management does not anticipate Peoples' current off-balance sheet activities will have a material impact on its future results of operations and financial condition based on historical experience and recent trends. |